The Truce That Could Save American Cities

Members of the American Federation of State, County and Municipal Employees Union, march to rally in front of the Maryland State Capitol building on March 14, 2011 to protest proposed changes to state workers pensions. (Image credit: Getty Images via @daylife)

Some states, such as New York and California, are loudly proclaiming that they have returned from the fiscal abyss. Maybe for now, but the future doesn't look so good when long-term debt and pension obligations are factored in. Taken together, our 50 states owe $1 trillion in unfunded pension obligations.

But right now the most severe and imminent fiscal crisis is in the nation’s cities. For one thing, some states are trying to improve their balance sheets by cutting aid to localities while imposing new mandates for everything from housing to green policies. Governors in states like Pennsylvania, New York and California have been pushing obligations down to levels of government below them. California Gov. Jerry Brown’s ‘Realignment’ strategy put the responsibility of state justice programs on local governments (though this came with promises of increased state aid). Brown also oversaw the dissolution of over 400 Finance Redevelopment Agencies, some of which may now be forced into bankruptcy. So while state debt is expected to decline by $1.7 billion next year, local debt is set to increase by $600 million.

Despite the mild recovery, many cities remain in dire fiscal straits. In April Moody's Investors Service warned it could downgrade the ratings of Chicago, Cincinnati, Minneapolis, Portland and 25 other local governments and school districts as part of a change in how it factors public pensions into debt grades. In Chicago, teachers' pensions alone cost $1 billion a year, while overall debt service accounts for close to a quarter of the city budget.

Seven major municipalities have already filed for bankruptcy, the largest being San Bernardino, Calif. The main cause is not hard to find: unfunded pension obligations to employees. A recent Lincoln Institute paper estimated that the aggregate unfunded liabilities of locally administered pension plans top $574 billion and eat up nearly 20% of municipal budgets. But the worst is yet to come. According to the Lincoln Institute's Anthony Flint, “If trends continue, over half of every dollar in tax revenue would go to pensions, and by some estimates in some cases would suck up 75% of all tax revenue.”

This dynamic will eventually be felt not only in long-term basket cases such as Detroit but also in America’s largest and most venerable cities such as Los Angeles, New York and Chicago. Part of the problem lies in legacy costs, similar to what we have seen in older industrial companies and airlines. The longer a municipality has been ladling out generous retirement benefits to public workers, the more they have to face the consequences, particularly as more retirees have the poor taste to live well into their eighties and beyond.

In New York, notes the Manhattan Institute’s Steve Malanga, annual pension costs during Michael Bloomberg's 12 years as mayor have grown from $1.8 billion to over $8 billion. According to the 2012 NYC budget, by 2015 these “legacy costs” will account for 25% of the city’s total budget, up from 16% in 2005. Overall these costs will have doubled over 10 years while other spending will have grown by barely 30%.

A crisis is also brewing in Los Angeles, a once youthful city whose rent-seeking developer and union-dominated political structure has turned it into an economic and fiscal laggard. Former Mayor Richard Riordan has predicted that unless pensions and compensation are reformed dramatically, the city will slide toward bankruptcy. The nation’s second-largest city faces a projected $800 million deficit over the next four years and pensions that are underfunded by at least $15 billion.

These huge obligations increasingly constitute a tax on the future of urban residents. As cities are forced to cough up ever more money to meet their retirement promises to workers, they become ever more incapable of addressing the basic infrastructure needs critical to maintaining economic competitiveness against younger, often faster-growing cities in less union-dominated parts of the country, notably in the South and Southwest, as well as newer, often more affluent suburban areas.

In the coming years count on the emergence of an increasingly dire conflict between urban boosters -- who long for everything from improved schools to more bike lanes and better transit -- and their traditional allies among the public-sector workforce. Essentially this will be not so much a war between conservatives and free-spending liberals, but what Walter Russell Mead has described as “blue on blue” conflict.

Conservatives, of course, have their own answers to this conundrum: large-scale budget cuts, severing of union contracts, privatization of essential services even if basic infrastructure deteriorate. All but the last alternative have some place in forward-looking urban strategy, but face enormous political challenges given the essentially one-party, union-oriented politics in most major cities. If a media-savvy plutocrat like Michael Bloomberg could not slow the expansion of the cost structure of New York, it’s unlikely that the more run of the mill mayors around the country can much succeed.

So is there a way out, short of the unlikely resurgence of conservative thinking in urban America? One possibility lies in restating urban priorities towards a City Hall focus on boosting the private sector as a means to meet at least some of its obligations. Rather than waging a war neither side can win, perhaps this new understanding could serve as the basis for a durable urban truce.

This, of course, requires a short course in economics for most urban officials and unions. The impending bankruptcy of cities such as Detroit, where service cutbacks and contract rollbacks are now the order of the day, should be held up as a stark lesson of what can happen. Continued tax increases, the preferred solution among progressives, are a mistake since they tend to drive businesses and middle class workers to places with less onerous burdens.

What needs to be drilled into the urban progressive mind is the basic reality that if the private economy fails, unions will find themselves confronted not by weak-kneed, weak-minded politicians they can own, but by bond holders, accountants, lawyers and judges who will press to either negate contracts or allow basic services to deteriorate to catastrophic levels.

At the same time, the private sector needs to recognize its inherent interest in the maintenance of efficient and reliable city services. Rather than simply denounce government, per se, the business community needs to appreciate the fundamental importance of the public sector to long-term economic growth. For much of western history urban infrastructure and efficient services played a critical role in the creation of strong urban economies.

This has been true as well in the United States, from the days of toll roads to late 19th century investments in water and sanitation systems. Modern Los Angeles would have been inconceivable without the aggressive, and often ruthless, building programs of the city-owned Department of Water and Power. And for all his many excesses, the resurgence of New York still rests on the road, bride and transit legacy created by the master builder Robert Moses.

These public efforts provided a basis for economic growth, that can generate revenues to pay city workers. Sadly this virtuous cycle has given way to a vicious one, with much of municipal spending wasted on economically questionable “bread and circuses” -- subsidized condo development, sports stadia, convention centers, arts programs, often marginal rail transit investments -- over more mundane investments in roads, bridges, buses, ports and the like. With rising interest rates imposing higher costs for infrastructure projects, the need to be judicious on spending priorities will become only greater.

To assure the future of our cities, deals need to be struck between workers and cities to temporarily keep down costs as cities try to snap out of the post-recession doldrums and develop stronger growth-based economies. In economically distressed Rhode Island, State Treasurer Gina Raimondo, a former venture capitalist, led an effort to save that state’s cities and towns about $100 million this fiscal year and $1 billion over the next 20 years.

Ultimately leaders in both the private and public sectors in cities need to recognize that the only way out of recurring crisis and inevitable decline lies in job-generating economic growth. Many of the cities with the best job growth are running budget surpluses , ranging from ultra-blue, union-dominated San Francisco to red state stalwarts such as Nashville, Fort Worth and Oklahoma City.

This suggests that business and governments need not only to restrain spending, but spend public funds in ways that are most likely to stimulate economic growth. There should be a strong discussion about municipal priorities -- they often differ somewhat by city – with the primary focus on those things that promote job creation and upward mobility. The urban future can not be secured by providing lavish retirements for city workers or subsidies for rent-seekers. Cities can only truly prosper by promoting that foster growth in ways that deliver real benefits to the vast majority of their citizens.